Scott Buchholz (Wright, Liberal Party) Share this | Hansard source

Thank you; you did too. So what are covered bonds? Essentially, they are quite similar to asset backed securities. They are attractive to investors because they have a very low credit risk. The investors which operate in these larger markets often require additional security measures for clients' funds under management or superannuation contributions. Covered bonds are very low risk because they are covered by an asset worth at least 103 per cent of their value. In this sense, the bonds are oversecured. But, of course, that means that in the event of insolvency the holders of covered bonds have the first right to the pool of assets ahead of the shareholders and the other holders of the debt. However, covered bonds differ from asset backed securities in two ways. The first difference is that the asset backed securities are backed only by certain specific assets. If those assets go bad, as happened in the US with some of the mortgage backed securities, the cash flows and the value of those bonds go with it. Take, for example, the subprime market in the US. You had banks that had books which were secured by bricks and mortar—mums' and dads' homes. The value of those assets softened—and softened drastically in the subprime market, up to 70 per cent. The banks sold part of their book to hedge their risk, and the person who bought part of the book then carried the risk with the softening of the asset.

Unlike covered bonds, the bad asset can be swapped out with good ones and, in the event that they go bad, this means that the quality of the asset backing the bond is always of the highest quality. Unlike an asset backed security, the covered bond offers the opportunity for the asset—the bricks and mortar—to be swapped for a stronger asset, for example, commercial properties that might be linked to valuation rates on commercial rentals, which would offer far more security and which would be held, of course, at that 103 per cent.

The other difference is that the covered bond debt and the underlying asset pool remain on the issuer's balance sheet. In the event of default, investors have recourse to both the pool assets and the issuer of that bond. These differences mean that the issuing institution can access cheaper and potentially more stable funding in the wholesale capital markets. It will also allow the ADIs, the authorised deposit-taking institutions, to increase the amount of funding they get from domestic sources, which, in turn, will help reduce their reliance on offshore markets for funding.

For example, we can look at our banks at the moment, our four corner banks. Using an indicative figure of, say, 50 per cent of funding secured from domestic markets and 50 per cent offshore—some of those ratios are slightly different, bearing out to sixty-forty, but if we use fifty-fifty as an example—the benefit for the banks having access to a new market to raise capital raises a couple of opportunities for them in reducing their risks to the global market in the current conditions. While the chances are that it will mainly be the bigger institutions who will use these bonds, any increase in domestic sources of funding for the financial system as a whole is worth while.

There is an element of pragmatism here too. With economic conditions overseas in a parlous state, some European banks are now finding it tough to raise funding in the wholesale markets. There are also escalating concerns about sovereign risk, with countries like Greece, Portugal and Ireland and the like considered of serious concern. While Australian banks have not been directly impacted by this tightening in the global funding market due to their reliance on offshore markets, it goes without saying that any tightening in the market can, and probably will, impact on the cost of funding for Australian banks. For that reason it makes sense to broaden the funding opportunities for our banks, and that is what covered bonds will do. Again, with the international risk that exists for our banks with the amount of money that we are exposed, this gives the banks a funding opportunity to harvest some of those funds domestically. Currently our superannuation firms that look for those covered bonds investments are forced offshore. They will head into international markets to get that security, because under the Banking Act we are unable to provide that.

Covered bonds are not some newfangled financial instrument. If anything, Australia is late coming to the party. The reason for this delay in Australia is that they do have a couple of shortcomings. First, by their nature covered bondholders have first claim over the pool of assets, pushing normal deposit holders further back in the queue. Second, because the asset pool backing covered bonds is rotated to ensure only 'good' assets are in place, there is a risk that bad assets will be left to cover the claims of other depositors. However, I believe this legislation has sufficient protections in place to ensure depositors are not left in the lurch.

It does this in two ways. The first is by limiting the proportion of Australian assets which can be committed to the covered bond pool to eight per cent—quite a minimum amount of exposure. Secondly, and probably most importantly, the Financial Claims Scheme provides a government guarantee for small depositors. The funds of the depositors are protected no matter their priority under the Banking Act.

Earlier this afternoon there was an opposition speaker to the bill from the crossbenches and two points he raised went to those particular concerns—knocking the depositor from the first place of security, and having the government taxpayer carry the risk. I want to rebut those points. As an opposition we would not support this bill if the depositors were exposed. I believe that the bill does give sufficient protection for depositors when you evaluate the risk. The bond pool is only eight per cent of the evaluating risk, leaving 92 per cent not exposed. The Australian banks then have the opportunity to increase their domestic market growth by having additional product which was not available to them historically. They also have the capacity to reduce exposure in the volatile markets in the current global conditions, and they do this with an intention of improving their liquidity.

He also raised the issue of the taxpayers and the government carrying the risk. In the last GFC downturn, the government provided the bank guarantee, so we are no strangers to extending a hand and trying to keep our market and our banking system strong. And, from this side of the House, I suggest that our banking system is one of the world-renowned banking models.

In conclusion, I would like to say that, while we on this side of the House approve of this legislation, the Treasurer's preferred method of financial regulation reform has been routinely substandard. In this, as in almost everything else this government does, there appears to be no master plan, no vision and no real objective—that is where I would stick in the nine-point plan, but I think you have heard that one so I will run over the top of that—instead, one gets the distinct impression that they are making it up as they go along. The competitive environment of both the Australian and the international finance systems has gone through enormous change since the global financial crisis. That is why we believe there is a need for a thorough review of the Australian financial system to decide what kind of system we want to see and what changes, if any, are required to achieve it. The coalition will support this bill, primarily because the concepts contained within it were our idea in the first place.

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